Depfa may be turned into 'bad bank' to control problem loans

DUBLIN-BASED Depfa bank may be turned into a bad bank to warehouse problem loans and other assets under a German government plan to break up its parent Hypo Real Estate.

Should Berlin proceed – it would first need to take control of Hypo as part of a rescue – this would be the first time a commercial German lender set up a “bad bank” with the federal government’s backing, setting a precedent for others.

It would also make Germany first in the euro zone area to establish such a state-backed shell for problem bank assets.

Even Britain, one of the countries worst affected by the financial crisis, opted instead to insure banks against further dips in the value of assets.

“Separating out problem port-folios lets the remaining healthy bank get on with its business of lending again,” said one source with detailed knowledge of the matter.

“It may not be perfect but I don’t think anyone has a better idea.”

German finance minister Peer Steinbrueck has thrown cold water on the idea of a national bad bank to mop up the mess created when the collapse in US subprime mortgages snowballed into a crisis of confidence in the financial system.

Steinbrueck has said, however, that banks could set up their own bad banks. This idea won support yesterday from a senior member of Chancellor Angela Merkel’s Christian Democrats.

Hypo could now be the first commercial bank to do so, following in the steps of regional state-backed lender WestLB.

With the federal government poised to take complete control of Hypo in return for bailing out the investment bank, responsibility for the bad bank would ultimately rest with Berlin. The government is examining a proposal, worked on by Hypo’s management, to break off its Dublin-based subsidiary Depfa plc and use it to house loans on its balance sheet which have dipped in value.

Depfa, a lender to governments which unravelled when interbank borrowing froze, would provide a ready-made warehouse for some of Hypo’s almost €260 billion ($334 billion) of loans, sources said.

“With Depfa plc, you have a bad bank or a structure you could use,” said another source. “Then the old Hypo and Depfa Deutschland could be run as a continuing business. This is one of the models you could use. The question is what goes in there and at what price.”

Hypo and the German finance ministry declined comment. The Department of Finance in Dublin also declined to comment.

Although Hypo does have some toxic assets, the bad bank would primarily house, for example, government loans that have plunged in value in the crisis.

As the bank’s owner, the Berlin government would be the ultimate backer for the new special purpose vehicle to put the assets in deep freeze for years in the hope that buyers return to the market and they recover their value. – (Reuters)